In the middle of the global financial crisis that knocked Wall Street and Main Street into the depths of a terrible recession, the Obama administration passed an emergency regulatory act named The Dodd-Frank Wall Street Reform and Consumer Protection Act.
In the simplest terms, Dodd-Frank is a mandatory set of regulations on financial institutions. In July 2010, President Barack Obama signed the massive financial reform legislation. In total, the law covered roughly 2,300 pages and was implemented over a period of several years with the intention to decrease various risks in the U.S. financial system. However, in many ways, the Dodd-Frank regulation has created many unintended consequences. The new financial regulatory framework may have restrained the economy’s recovery and expanded the number of firms that are too big to fail.
Today, we see consumers having fewer choices of financial products and services and ending up with little more protection than before. The act has curtailed the startup of some new small banks. Many fewer exist than at the time Dodd-Frank was passed. In addition, Lloyd Blankfein, CEO of Goldman Sachs, commented: “More intense regulatory requirements have raised the barriers to entry higher than at any other time in modern history. This is an expensive business to be in. Consider the numerous business exits that have been announced by our peers as they reassessed their competitive positioning and relative returns.”
Dodd-Frank requires new capital standards, derivative rules and interchange fees, all making it more challenging for smaller financial institutions with low market capital. The law has made it more difficult for smaller firms to compete against the financial giants and brought more non-banks into markets, especially, as of late, into mortgage markets.
What is also disconcerting to me about Dodd-Frank is the authority it gives government officials to control financial markets. In essence, what this leaves us with is a situation where two groups, big bankers and government officials, are in very influential positions. On the one hand, we have really big financial institutions with more market dominance than before and, on the other hand, we have government officials, some of whom do not really understand the industry they are trying to regulate and create legislation for.
So how will commentators view Dodd-Frank over the long term? To answer this, it may be useful to see what happened at the time of the last big change in banking legislation and regulation. That came at the time of the repeal of the Glass Steagall Act of 1933. This act was passed by Congress as an emergency response to the Great Depression and prohibited the marriage of commercial banking (making loans) and merchant banking (making equity deals for a bank’s own account). It was during Bill Clinton’s time in the Oval Office that the repeal took place, in 1999. With its repeal came unintended consequences. Some say that mixing commercial banks and merchant banks arguably led to the crisis in 2008. Others feel this financial deregulation was the greatest thing since sliced bread. It is interesting to note that the Volcker Rule, passed as part of Dodd-Frank, brought part of Glass Steagall back into place.
There are no easy answers to financial regulation and it will be fascinating to see what President Donald Trump does.
John Hoffmire is director of the Impact Bond Fund at Saïd Business School at Oxford University and directs the Center on Business and Poverty at the Wisconsin School of Business at UW-Madison. He runs Progress Through Business, a nonprofit group promoting economic development. Sidney Draughon and Sam Sherman, Hoffmire’s colleagues at Progress Through Business, did the research for this article.